Process of Accounting

Accounting process is a systematic series of steps that businesses follow to identify, record, classify, summarize, and report financial transactions. This process ensures that financial data is accurate, relevant, and useful for decision-making. The accounting process can be broken down into several key stages, each with specific tasks and objectives.

1. Identification of Transactions

The first step in the accounting process is identifying the financial transactions that need to be recorded. A transaction is any event that has a financial impact on the business. This can include sales, purchases, receipts, payments, and any other events that affect the financial position of the business. To accurately identify these transactions, businesses need to gather source documents, such as invoices, receipts, bank statements, and contracts, which serve as evidence of the transaction.

2. Recording Transactions (Journal Entries)

Once transactions have been identified, the next step is to record them in the accounting system. This is done through journal entries, which are detailed records of each transaction that include the date, accounts affected, amounts, and a brief description of the transaction. Journal entries follow the double-entry accounting system, meaning that every transaction impacts at least two accounts—one account is debited, and another is credited. For example, if a business sells a product for cash, the Cash account is debited, while the Sales Revenue account is credited.

3. Posting to the Ledger

After journal entries are recorded, they are posted to the general ledger. The ledger is a collection of accounts that summarizes all financial transactions for a business. Each account in the ledger contains a record of all debits and credits affecting that account over time. For instance, the Cash account will show all cash inflows and outflows, while the Sales Revenue account will reflect total sales. Posting to the ledger allows businesses to maintain a comprehensive record of all financial activities.

4. Trial Balance Preparation

Once all transactions have been posted to the ledger, the next step is to prepare a trial balance. A trial balance is a summary that lists all the accounts and their balances at a specific point in time, with debits and credits tallied. The purpose of the trial balance is to ensure that the total debits equal the total credits, confirming that the accounting records are mathematically accurate. If the trial balance does not balance, it indicates that there may be errors in the journal entries or postings, requiring further investigation.

5. Adjusting Entries

To ensure that financial statements reflect the true financial position of the business, adjusting entries are made at the end of the accounting period. Adjusting entries are necessary for accrual accounting, where revenues and expenses must be recognized in the period they occur, regardless of cash transactions. Common types of adjustments include accruals (recognizing revenue or expenses not yet recorded) and deferrals (adjusting previously recorded revenues or expenses). For example, if a business has incurred expenses but not yet paid for them, an adjusting entry would recognize those expenses in the current period.

6. Adjusted Trial Balance

After making the necessary adjusting entries, an adjusted trial balance is prepared. This trial balance reflects the updated account balances after the adjustments. The adjusted trial balance is crucial as it serves as the basis for preparing the financial statements, ensuring that the financial data is accurate and complete.

7. Financial Statement Preparation

With the adjusted trial balance in hand, businesses can prepare their financial statements. The primary financial statements include the income statement, balance sheet, and cash flow statement.

• Income Statement: This statement summarizes revenues and expenses over a specific period, resulting in net income or loss.
• Balance Sheet: The balance sheet presents the company’s assets, liabilities, and equity at a particular point in time, providing a snapshot of the business’s financial position.
• Cash Flow Statement: This statement outlines the cash inflows and outflows during a specific period, categorized into operating, investing, and financing activities.

8. Closing Entries

After the financial statements have been prepared and reviewed, closing entries are made to reset temporary accounts (like revenues and expenses) for the new accounting period. Closing entries transfer the balances from these temporary accounts to the retained earnings account in the equity section of the balance sheet. This ensures that the new accounting period starts with a clean slate, with only permanent accounts carrying forward their balances.

9. Post-Closing Trial Balance

The final step in the accounting process is preparing a post-closing trial balance. This trial balance includes only permanent accounts (assets, liabilities, and equity) after closing entries have been made. The post-closing trial balance confirms that the books are balanced and ready for the next accounting period.